The Gold Exchange and The Bretton Woods Agreement

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The Gold Exchange and the Bretton Woods Agreement

In 1967, a Chicago bank refused a college professor by the name of Milton Friedman a
loan in pound sterling because he had intended to use the funds to short the British
currency. Friedman, who had perceived sterling to be priced too high against the dollar,
wanted to sell the currency, then later buy it back to repay the bank after the currency
declined, thus pocketing a quick profit. The bank’s refusal to grant the loan was due to
the Bretton Woods Agreement, established twenty years earlier, which fixed national
currencies against the dollar, and set the dollar at a rate of $35 per ounce of gold. 

The Bretton Woods Agreement, set up in 1944, aimed at installing international


monetary stability by preventing money from fleeing across nations, and restricting
speculation in the world currencies. Prior to the Agreement, the gold exchange
standard--prevailing between 1876 and World War I--dominated the international
economic system. Under the gold exchange, currencies gained a new phase of stability
as they were backed by the price of gold. It abolished the age-old practice used by
kings and rulers of arbitrarily debasing money and triggering inflation. 

But the gold exchange standard didn’t lack faults. As an economy strengthened, it
would import heavily from abroad until it ran down its gold reserves required to back its
money; consequently, the money supply would shrink, interest rates rose and economic
activity slowed to the extent of recession. Ultimately, prices of goods had hit bottom,
appearing attractive to other nations, who would rush into buying sprees that injected
the economy with gold until it increased its money supply, and drive down interest rates
and recreate wealth into the economy. Such boom-bust patterns prevailed throughout
the gold standard until the outbreak of World War I interrupted trade flows and the
free movement of gold. 

After the Wars, the Bretton Woods Agreement was founded, where participating
countries agreed to try and maintain the value of their currency with a narrow margin
against the dollar and a corresponding rate of gold as needed. Countries were
prohibited from devaluing their currencies to their trade advantage and were only
allowed to do so for devaluations of less than 10%. Into the 1950s, the ever-expanding
volume of international trade led to massive movements of capital generated by post-
war construction. That destabilized foreign exchange rates as setup in Bretton Woods. 

The Agreement was finally abandoned in 1971, and the US dollar would no longer be
convertible into gold. By 1973, currencies of major industrialized nations floated more
freely, as they were controlled mainly by the forces of supply and demand. Prices were
floated daily, with volumes, speed and price volatility all increasing throughout the
1970s, giving rise to new financial instruments, market deregulation and trade
liberalization. 

In the 1980s, cross-border capital movements accelerated with the advent of computers
and technology, extending market continuum through Asian, European and American
time zones. Transactions in foreign exchange rocketed from about $70 billion a day in
the 1980s, to more than $1.5 trillion a day two decades later. 

The Explosion of the Euromarket

A major catalyst to the acceleration of Forex trading was the rapid development of the
eurodollar market; where US dollars are deposited in banks outside the US. Similarly,
Euromarkets are those where assets are deposited outside the currency of origin. The
Eurodollar market first came into being in the 1950s when Russia’s oil revenue-- all in
dollars -- was deposited outside the US in fear of being frozen by US regulators. That
gave rise to a vast offshore pool of dollars outside the control of US authorities. The US
government imposed laws to restrict dollar lending to foreigners. Euromarkets were
particularly attractive because they had far less regulations and offered higher yields.
From the late 1980s onwards, US companies began to borrow offshore, finding
Euromarkets a beneficial center for holding excess liquidity, providing short-term loans
and financing imports and exports. 

London was, and remains the principal offshore market. In the 1980s, it became the key
center in the Eurodollar market when British banks began lending dollars as an
alternative to pounds in order to maintain their leading position in global finance.
London’s convenient geographical location (operating during Asian and American
markets) is also instrumental in preserving its dominance in the Euromarket.

The History of FOREX Trading


The origin of Forex trading traces its history to centuries ago. Different
currencies and the need to exchange them had existed since the
Babylonians. They are credited with the first use of paper notes and
receipts. Speculation hardly ever happened, and certainly the enormous
speculative activity in the market today would have been frowned upon.
In those days, the value of goods were expressed in terms of other
goods(also called as the Barter System). The obvious limitations of such a
system encouraged establishing more generally accepted mediums of
exchange. It was important that a common base of value could be
established. In some economies, items such as teeth, feathers even stones
served this purpose, but soon various metals, in particular gold and silver,
established themselves as an accepted means of payment as well as a
reliable storage of value. Trade was carried among people of Africa, Asia etc
through this system.
Coins were initially minted from the preferred metal and in stable
political regimes, the introduction of a paper form of governmental I.O.U.
during the Middle Ages also gained acceptance. This type of I.O.U. was
introduced more successfully through force than through persuasion and is
now the basis of today's modern currencies.
Before the First World war, most Central banks supported their currencies
with convertibility to gold. However, the gold exchange standard had its
weaknesses of boom-bust patterns. As an economy strengthened, it would
import a great deal from out of the country until it ran down its gold
reserves required to support its money; as a result, the money supply would
diminish, interest rates escalate and economic activity slowed to the point
of recession. Ultimately, prices of commodities had hit bottom, appearing
attractive to other nations, who would sprint into buying fury that injected
the economy with gold until it increased its money supply, drive down
interest rates and restore wealth into the economy.. However, for this type
of gold exchange, there was not necessarily a Centrals bank need for full
coverage of the government's currency reserves. This did not occur very
often, however when a group mindset fostered this disastrous notion of
converting back to gold in mass, panic resulted in so-called "Run on banks "
The combination of a greater supply of paper money without the gold to
cover led to devastating inflation and resulting political instability. The
Great Depression and the removal of the gold standard in 1931 created a
serious lull in Forex market activity. From 1931 until 1973, the Forex market
went through a series of changes. These changes greatly affected the global
economies at the time and speculation in the Forex markets during these
times was little.
In order to protect local national interests, increased foreign exchange
controls were introduced to prevent market forces from punishing monetary
irresponsibility.
Near the end of World War II, the Bretton Woods agreement was reached
on the initiative of the USA in July 1944. The conference held in Bretton
Woods, New Hampshire rejected John Maynard Keynes suggestion for a new
world reserve currency in favor of a system built on the US Dollar.
International institutions such as the IMF, The World Bank and GATT were
created in the same period as the emerging victors of WWII searched for a
way to avoid the destabilizing monetary crises leading to the war. The
Bretton Woods agreement resulted in a system of fixed exchange rates that
reinstated The Gold Standard partly, fixing the USD at $35.00 per ounce of
Gold and fixing the other main currencies to the dollar, initially intended to
be on a permanent basis.
The Bretton Woods system came under increasing pressure as national
economies moved in different directions during the 1960's. A number of
realignments held the system alive for a long time but eventually Bretton
Woods collapsed in the early 1970's following president Nixon's suspension of
the gold convertibility in August 1971. The dollar was not any longer suited
as the sole international currency at a time when it was under severe
pressure from increasing US budget and trade deficits.
The last few decades have seen foreign exchange trading develop into the
world's largest global market. Restrictions on capital flows have been
removed in most countries, leaving the market forces free to adjust foreign
exchange rates according to their perceived values.
The European Economic Community introduced a new system of fixed
exchange rates in 1979, the European Monetary System. The quest
continued in Europe for currency stability with the 1991 signing of The
Maastricht treaty. This was to not only fix exchange rates but also actually
replace many of them with the Euro in 2002. London was, and remains the
principal offshore market. In the 1980s, it became the key center in the
Eurodollar market when British banks began lending dollars as an alternative
to pounds in order to maintain their leading position in global finance.
In Asia, the lack of sustainability of fixed foreign exchange rates has
gained new relevance with the events in South East Asia in the latter part of
1997, where currency after currency was devalued against the US dollar,
leaving other fixed exchange rates in particular in South America also
looking very vulnerable.
While commercial companies have had to face a much more volatile
currency environment in recent years, investors and financial institutions
have discovered a new playground. The Forex exchange market initially
worked under the central banks and the governmental institutions but later
on it accommodated the various institutions, at present it also includes the
dot com booms and the world wide web. The size of the Forex market now
dwarfs any other investment market. The foreign exchange market is the
largest financial market in the world. Approximately 1.9 trillion dollars are
traded daily in the foreign exchange market. It is estimated that more than
USD 1,200 Billion are traded every day. It can be said easily that Forex
market is a lucrative opportunity for the modern day savvy investor.

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